Google (GOOG) Faces Major Challenges in 2012

Shares of search giant Google (GOOG: Charts, News) slid last Friday despite posting strong first quarter earnings that topped analyst estimates. The Mountain View, California-based company posted a profit of $8.75 per share, or $2.89 billion. This was a 61% improvement from the $5.51 per share, or $1.8 billion, it posted in the prior year quarter.

Excluding stock-based compensation, earnings increased 24.8% from $8.08 per share to $10.08 per share. Total revenue rose 24% to $10.65 billion. Analysts had expected earnings of $9.65 per share, on the same basis, on revenue of $8.15 billion.

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Google attributed its strong earnings to an increase in click volume. However, the amount advertisers paid per click declined from the previous year. U.S. paid clicks rose 39% from the previous year and 7% from the previous quarter. On the flip side, the average cost paid by advertisers dropped 12% from the previous year and 6% from the fourth quarter. During the quarter, total costs rose 16%, mainly caused by investments in new products, advertising, new hires and worker compensation. Growth in costs continues to outpace revenue growth, a major problem that bearish analysts are quick to highlight. Google has been continuing this trend all throughout 2011, and 2012 looks like more of the same.

Despite Android's popularity, Google has failed to capitalize on the massive "Android Army" of handset makers led by Samsung. Instead, the company has relied on search queries and clicks from Android-equipped mobile devices, which generate less revenue than ads on desktop or laptop platforms. As users steadily adopt more tablets, smartphones and hybrid devices, Google may find itself in a losing position with mobile ads generating less revenue per click. Cost per click has fallen for three consecutive quarters.

Google also faces major headwinds in 2012 from major competitors. These competitors have aligned themselves against Google, which could erect formidable hurdles across multiple business segments. Microsoft (MSFT: Charts, News) is currently allied with Facebook, Nokia (NOK: Charts, News) and Baidu (BIDU: Charts, News), for the respective purposes of social networking, mobile and search. Microsoft's recent patent blitz, in which it acquired 800 patents from America Online (AOL: Charts, News), is squarely aimed at defending against any further incursions by Google in the cloud computing, social networking and search arenas. To date, Google+ has failed to dent Facebook's dominant market share, despite Larry Page's best efforts. Facebook's upcoming May IPO could further push Google+ into obscurity.

Meanwhile, Google's nemesis Apple (AAPL: Charts, News) has reportedly allied with Baidu in China, using the Beijing-based search engine as the default search engine on its iOS products in the massively untapped market. To add insult to injury, many Chinese tablet and smartphone vendors, who use Android, have legally removed Google search from their products in favor of Baidu or other local search engines, cutting Google out of the picture altogether. Google's Chinese search engine, which sends users to its Hong Kong portal, now holds a slim 5% of China's search market. Baidu controls 80%.

Analysts are also concerned that Google's ongoing $12.5 billion takeover of Motorola Mobility (MMI: Charts, News) could cause acquisition indigestion and dent the company's margins in the coming year. However, others believe that Google will strip mine the company for its patents and scale back its handset operations considerably.

Following in Apple's (AAPL: Charts, News) footsteps, Google also announced a dividend, along with a two-for-one stock split. This decision affirmed expectations that Google would split its stock to attract new investors. The split was also connected to Google's plan to create a new class of non-voting capital stock to be listed separately on the Nasdaq. Analysts believe that this will further extend management's control over the company, which already shuts out investors by granting each executive board member special stock with 10 times the voting privileges of the common stock.

Shares of Google are considered undervalued, trading at 12.65 times forward earnings with a 5-year PEG ratio of 0.81. Its upcoming dividend is expected to be announced on Thursday.

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Published on Apr 16, 2012

By Leo Sun

Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.